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There's nothing like a grandstanding member of Congress to deflect attention from the real issues at hand by throwing a few juicy bones to the masses.
Most legislators at a House Finance subcommittee hearing last week deftly avoided the real story of AIG's collapse. Instead, they homed in on the public relations disaster of hundreds of top AIG officials and staff getting $165 million (later revealed as over $218 million) in bonuses.
The key issue ignored by the congressmen and women was the potential catastrophe represented by as much as $2.7 trillion in AIG derivative contracts and how AIG and the U.S. government are dealing with them. To put that number in context, we've so far provided the company only about $170 billion.
An exception at the hearing was Rep. Joe Donnelly, D-Ind., who declared that "naked credit default swaps" were little more than "gambling ... dreamed up" by Wall Street to create additional profits, and he suggested that instead of being bailed out, "when the casino goes bust, the guys who are gambling close shop."
He noted that if ordinary Indiana citizens acted the same way as the titans of Wall Street had, they'd be in jail. But Donnelly never got to explain what he meant by "naked credit default swaps."
We did learn early at the hearing that the Federal Reserve is in charge of overseeing AIG. The Fed is strongly influenced by some of the same big banks and brokerages that are getting AIG payouts and taxpayer funding.
These same firms have opposed regulating credit default swaps, other derivatives and naked short selling (which are explained below). That should have set the stage for the rest of the questions, not to mention an investigation into where, exactly, all that money that AIG received went.
More Money for AIG
We discovered in passing at the hearing that AIG has $1.6 trillion of derivatives left to "unwind" -- the mess remaining of the AIG derivatives debacle. Nobody asked the basic details of how the other $1.1 trillion was "unwound" or how the rest will be dealt with. And nobody got an answer to the question of how much more in taxpayer money it will take to finish the job, and who will benefit from this unwinding process. Or, since the U.S. government is now in the derivatives business through its financial support of not only AIG but also Citigroup ($300 billion in guarantees), and other financial companies, how much taxpayer money may be required to pay off those other firms' derivatives bets.
Derivatives are financial instruments derived from something else, hence the name. In the lingo of Wall Street, nouns are turned into verbs and verbs beget nouns. If a bank or brokerage firm "securitizes" debt -- for example, turning a bundle of mortgages into financial products -- the resulting securities are derived from those mortgages, thus they are mortgage "derivatives." They can be sliced and diced and sold and, at the insistence of Wall Street powers and their representatives, the derivative transactions are unregulated.
Central to AIG's demise were derivative credit default swaps (CDS), basically insurance on financial deals. Some people bought insurance against their houses burning down. Others made bets on somebody else's house burning down. That's an insurance policy for someone without a house at risk.
The first type of contract should be seen as legitimate. But should U.S. taxpayers, who own nearly 80 percent of AIG, pay off a wager that somebody else's house would burn down in this financial casino Wall Street built out of the ashes of cut-and-burn deregulation?
More importantly: Should they pay off the wager if there are indications that the game may have been rigged in the first place?
Hedging the Bets
Derivatives contracts on stocks can be "hedged" with a short sale.
Short selling is selling a stock that you borrow. The short-seller hopes the price will go down in order to buy the security cheaper and transfer it back to the lender, gaining a profit from the difference in prices from the time the shares were borrowed and the time the shares were returned to the lender.
Naked short selling is selling shares that were never borrowed -- it's selling thin air, or in essence, selling counterfeit securities. Done on a large scale, this pushes down share prices across the board as the artificial supply of shares -- ballooned by those phantom shares -- outweighs demand.
The Securities and Exchange Commission's real effort in stopping naked short selling has been on a par with its interest in investigating Bernie Madoff.
Lucy Komisar is an investigative journalist who focuses on offshore and financial corruption. Her articles are posted at the Komisar Scoop.